Paying for Renewable Energy: TLC at the Right Price

Transcription

1 Paying for Renewable Energy: TLC at the Right Price Achieving Scale through Efficient Policy Design December 2009 Green policy paper available online: Carbon Counter widget available for download at:

2 Climate Change Investment Research Mark Fulton Managing Director Global Head of Climate Change Investment Research New York Bruce M. Kahn, Ph.D. Director Senior Investment Analyst: New York Nils Mellquist Vice President Senior Research Analyst: New York Emily Soong Associate New York Jake Baker Research Analyst New York Lucy Cotter Research Analyst London We would like to thank the following contributors: Christina Benoit Hanley, MPPA London School of Economics & Hertie School of Governance Lead Author of Sections III and IV (Feed-in Tariffs) Wilson Rickerson Executive Vice President, Meister Consultants Group, Inc. We would like to thank the following individuals for their insight: Tobias Just, Director, Head of Sector and Real Estate Research, DB Research Sabine Miltner, Ph.D., Director, Office of the Vice Chairman, Deutsche Bank Mark Dominik, Vice President, Office of the Vice Chairman, Deutsche Bank Toby Couture, E3 Analytics Paul Gipe, Renewable Industry Analyst, Wind-Works.org David Jacobs, Co-author of Powering the Green Economy: The Feed-in Tariff Handbook Craig Lewis, Founding Principal, RightCycle Jonathan McClelland, Director, Energy & Environmental Services, M.J. Beck Consulting, LLC 2 Paying for Renewable Energy: TLC at the Right Price

3 Editorial Letter Kevin Parker Member of the Group Executive Committee Global Head of Asset Management TLC: Transparency, Longevity and Certainty, drives investment. As investors, this has been our message to policy makers for much of In our Global Climate Policy Tracker report* we rated the risk of climate change policy regimes of countries around the world against TLC. A key factor in these ratings was our belief that Feed in Tariffs (FiTs) create a lower risk environment for investors. This follow up paper focuses specifically on the mandates and incentives that can best complement the emerging carbon markets, which we believe hold the long term policy solution. With governments announcing more targets at Copenhagen, delivering on these through complementary policies on the ground right now is ever more important. We then set out what we consider to be the most advanced features of FiTs that can stimulate investment on a large scale while containing costs and maintaining TLC. A critical feature of a successful FiT regime is periodic reviews, conducted in a transparent manner, of its progress and effectiveness. Such reviews are used to respond to changing market conditions in renewable technologies so that a fair return is established for investors. The recently announced review of solar tariffs by the German government is an example. This policy green paper therefore sets out our view of the optimal features of an advanced FiT. Germany remains a leading example, and in North America the province on Ontario has emerged with a particularly strong policy. We regard these policies as applicable at a country, province, state or city level, anywhere in the world. In the US, some States are already in the process of introducing or researching FiTs. There is even a national proposal in Congress. Although critics of FiTs argue that they are unacceptably expensive, our research shows that they are not only efficient but that the introduction of the key elements of FiTs in the US is a practical option. It would require certain adjustments to the existing electricity pricing structure rather than a wholesale replacement of the system. Significantly, our research points out that the US Renewable Portfolio Standard (RPS) and Renewable Energy Credit (REC) markets already perform the same function as a FiT when bundled with a Power Purchasing Agreement (PPA). There is very little transparency or certainty in the existing pricing process which is essentially based on a contract by contract negotiation. However, as our research demonstrates, it is possible to adopt the advanced features into the PPA/REC framework. *DBCCA, Global Climate Change Policy Tracker: An Investor s Assessment, October Paying for Renewable Energy: TLC at the Right Price

4 Executive Summary The scale-up of renewable energy can satisfy a number of policy and economic goals including: emissions targets, energy security and job creation in the green sector. Renewable energy incentives can be integrated into carbon markets and play the role of a Research, Development and Demonstration (RD&D) incentive while proven technologies are in their learning phase. Investors want Transparency, Longevity and Certainty TLC in order to deploy capital. There needs to be a transparent process that gives a reasonably certain rate of return over a long timeframe. This should reduce the cost of capital. However, public support is required for this to endure, so cost and price effectiveness are crucial. Building on our work on German feed-in tariffs (FiTs) 1 and our Global Climate Change Policy Tracker 2, we further look at how renewable energy policy regimes can achieve an optimal mix of TLC at the right price. In the current economic environment, this could be seen as job creation with energy security and climate protection at the most efficient cost. In doing this, we examine five FiT regimes and set out what makes them advanced while still delivering enough TLC to achieve scale. Advanced features include cost/price discovery processes and the flexibility to respond to markets, while still operating within a transparent framework. Germany in particular stands out and is able to demonstrate many benefits that come with a strong volume response while being responsive to significant market developments. In a North American context, the province of Ontario has many features of a strong policy design. For contrast, we then analyze the US renewable policy framework in the context of US electricity markets. The structure is complex, fragmented and lacks many elements of TLC. It attempts to reach for a pure market, lowest cost solution using Renewable Portfolio Standards (RPS) and Renewable Energy Certificates (RECs), interacting with Federal and other incentives. This can deliver results only if long term hedgeable REC markets emerge as Federal incentives also start expiring in Given the challenges of developing more stable and transparent REC markets, in our view, the best features of advanced FiTs can be integrated into the REC market via establishing a floor price which is also subject to advanced price discovery features. Standardizing the renewable energy contract then completes transparency. This can become the basis for constructing power purchase agreements (PPAs) in the US. PPAs should continue to reflect all other incentive features of the US policy scheme as they are set. This would add a crucial level of TLC for investors and enable renewable energy scale-up. Given the complexity of the US regulatory landscape, many believe this works best at the state level. Having said that, there is some cost to all incentive regimes, however well they are managed over time. That cost can be passed straight through to the consumer or spread across the tax base. However this is done, the public needs to see the benefits: job growth, secure energy and a positive environmental impact. 1 DBCCA, Creating Jobs & Growth: The German Green Experience, September DBCCA, Global Climate Change Policy Tracker: An Investor s Assessment, November Paying for Renewable Energy: TLC at the Right Price

5 Executive Summary Key aspects of an advanced feed-in tariff (FiT) design In many respects, at the core of our paper is the analysis of what we term advanced FiT policy design. This is set out in Chapter II. Below, we have extracted what we consider to be the key features we would recommend to be included in a FiT, tracked against the key regimes we have examined. It is these features that we believe can deliver TLC at the right price. FIT Design Features Policy & Economic Framework Core Elements Key Factors "Linkage" to mandates & targets Eligible technologies Specified tariff by technology Standard offer/ guaranteed payment TLC at the Right Price France Germany Netherlands Ontario Spain Yes 23% by % by % by 2020 All renewables eligible Wind, Solar, Geothermal, Small hydro, Biomass, Biogas Wind, Solar, Geothermal, Small hydro, Biomass, Biogas Wind, Solar, Biomass, Biogas, CHP Halt coal use by 2014 Wind, Solar, Hydro, Biomass, Biogas 20% by 2020 Wind, Solar (PV & CSP), Geo, Small hydro, Biomass, Biogas Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Interconnection Yes Yes Yes Yes Yes Yes Payment term 15-25yrs 15-20yrs 20yrs 15yrs 20yrs 15-25yrs Supply & Demand How to set price Must take Yes No Yes No Yes Yes Who operates (most common) Open to all IPPs; communities; utilities IPPs; communities; utilities Fixed Structure & Adjustment IPPs; communities IPPs; communities IPPs, communities; utilities Fixed vs. variable price Fixed Fixed Fixed Hybrid Fixed Both Generation cost vs. avoided cost Generation Generation Generation Generation Generation Generation IRR target Yes 8% 5-7% No 11% 7-10% How to adjust price Caps Degression Yes Wind only Yes No No No Periodic review Yes No Yes Yes Yes Yes Grid parity target Yes No Yes No No No Project size cap Policy Eligible for other interactions incentives Transaction costs Streamlining minimized Source: DBCCA analysis, Depends on context Yes - eligible to take choice Varies No Yes PV only Yes Yes Yes Yes Yes Yes Yes Yes Yes No Yes No 5 Paying for Renewable Energy: TLC at the Right Price

6 Table of Contents I. Paying for Renewable Energy: Costs, Benefits and Jobs 1.0 A more detailed cost-benefit analysis of the German FiT regime 2.0 Ontario looking to create a competitive lowcarbon growth economy 3.0 Fossil fuel subsidy costs Also a factor to consider II. Renewable Energy Policies: Key Design Features 1.0 The climate policy framework for renewable energy 2.0 Investor response 3.0 Optimizing policy: TLC at the right price 3.1 Policy levers What s available 4.0 Looking at feed-in tariffs Standard offer renewable payments 4.1 Looking for TLC with price discovery 4.2 How advanced are recent FiTs Germany and Ontario? 5.0 Contrasting US renewable markets: RECs, federal policy and PPAs 6.0 Other incentives: Loan guarantees and infrastructure 7.0 Renewable energy payments - Reconciling policy regimes III. DBCCA Feed-in Tariff Matrix IV. Feed-in Tariffs 1.0 Core feed-in tariff principles 2.0 Policy and economic framework 2.1 Linkage to mandates and targets 2.2 Electricity market structure 2.3 In-State/Country content requirements 2.4 Year current FiT established 3.0 Core elements 3.1 Eligible technologies 3.2 Specified tariff by technology 3.3 Standard offer / Guaranteed payment 3.4 Interconnection 3.5 Payment term 4.0 Supply & demand 4.1 Must take 4.2 Who operates 4.3 Who buys 4.4 Who pays 5.0 FiT structure & adjustment 5.1 How to set the price Pg. 8 Pg. 13 Pg. 24 Pg How to adjust the price 5.3 Caps 5.4 Bonus options 5.5 Policy interactions 5.6 Streamlining 6.0 Outcomes 6.1 Investor IRRs 6.2 Job creation 6.3 Total primary renewable energy produced (GWh) 6.4 Technology deployment by ownership 6.5 Critiques of feed-in tariffs 7.0 Conclusion V. US Renewable Payments Market Pg Introduction: The US - A complex electricity system collides with a complex renewables structure 2.0 Pricing electricity: The role of PPAs 3.0 Renewable Portfolio Standards (RPS): Volume approach to achieving environmental goals with energy security 4.0 Renewable Energy Certificates (RECs) 4.1 RPS, REC and advanced FiT interaction with CO 2 prices 5.0 Other incentives: Federal 5.1 ITC & PTC 5.2 Tax equity market 5.3 Convertible Investment Tax Credit Cash Grant 5.4 US DoE Loan Guarantees 5.5 Clean Energy Deployment Agency (CEDA) 5.6 Clean Energy Renewable Bond (CERB) 5.7 US feed-in tariffs 6.0 Financing a renewable energy project VI. Reconciling Policies: The Standard Offer Payment 1.0 Interaction and reconciliation of advanced renewable payments with current policy 2.0 A Green Bank Appendix: Examples of renewable energy incentives by country Pg. 62 Pg Paying for Renewable Energy: TLC at the Right Price

7 List of Exhibits & Boxes EX 1: Feed-in Tariff policy outcomes EX 2: Timeline and incentive structure to achieve commercial break-even (grid parity) for a technology EX 3: 2030 Global GHG incremental abatement cost and technical potential vs. current technical maturity EX 4: Key features for TLC at the right price EX 5: Efficient tariff pathway to grid parity EX 6: Map of renewable energy policy framework EX 7: 2020 Renewable electricity goals EX 8: Comparison of case study electricity markets EX 9: 2009 PV Solar Installation Payments under the German EEG EX 10: Overview of 2009 EEG Renewables Payments EX 11: 2009 Solar PV installation payments under the EEG EX 12: Estimated employees in wind sector in 2009 EX 13: Comparison of primary renewable electricity produced Hydro, Solar & Wind (Annual GWh) EX 14: Comparison of primary renewable electricity produced Solar & Wind (Annual GWh) EX 15: State RPS mandates: Driving force behind renewable deployment in the US - Renewable energy % US demand (TWh) based on state RPS mandates EX 16: State RPS mandates: Driving force behind renewable deployment in the US - US RPS Policies with Multipliers and/or Carve-outs for Solar and Distributed Generation EX 17: Components of REC pricing EX 18: Summary of various renewable energy subsidy mechanisms EX 19: Summary of various renewable energy subsidy mechanisms EX 20: US wind capacity additions dependent on PTC EX 21: Timeline comparison of US tax credit options EX 22: Comparison of tax credit options and choices from ARRA EX 23: Map of renewable energy policy framework Box 1.1: Box 1.2: Box 2: Box 3: Box 4: Box 5: Box 6: Evaluating costs and benefits of the German feed-in tariff A closer examination of the benefits from the German FiT Ontario Looking for significant economic benefits The role of subsidies: Fossil fuels much more heavily subsidized than renewable energy Current review of the German FiT payments Lessons learned from the Spanish FiT PURPA: The first attempt at a standard offer in the US 7 Paying for Renewable Energy: TLC at the Right Price

8 I. Paying for Renewable Energy: Costs, Benefits And Jobs Summary: Governments need to support budget spending programs that create jobs and economic benefits. Even leaving aside any idea of offsetting the long term costs of failing to achieve climate goals, there are a significant number of measurable benefits that outweigh the costs in well-designed renewable energy policy regimes. The German government in particular, has done the analysis illustrating this point while being responsive to significant market developments. Ontario also expects the benefits of developing its energy policies will make it a competitor in a low-carbon economy. Further work needs to be done on the costs of subsidizing fossil fuels. In evaluating the costs and benefits of renewable energy payments to achieve scale, there are a number of obvious factors that need to be considered: 1. How much clean power is delivered from the policy (as a percentage of total generation)? Does the policy meet environmental goals? 2. How many jobs are created as a consequence? 3. What is the cost to either the electricity consumer (ratepayer) or the taxpayer of the incentives and spending programs? 4. What is the impact on the economy to industry growth and exports? However, there are other key economic implications: 1. What is the impact on energy security as measured by changes to the imports of fossil fuels? 2. What is the merit order effect in the electricity market and how much might it affect prices? 3. Is there a measurable impact on innovation and patents? Evaluating costs and benefits in electricity markets is a complex economic calculation that does not lend itself to a simple net result. We believe this is an area that will require more research in the future for renewable energy markets. In this paper, we have looked at feed-in tariff regimes in Europe and Ontario as well as discussed the US electricity market for renewables. Below is a high-level look at two of the key economic aggregates that are more readily available as a result of these policies and potential initiatives. EX 1: Feed-in tariff policy outcomes France Germany Netherlands Ontario Spain Job creation (gross) 7,000 (wind) 280, (wind) Est. 50, ,000 RE generation as a share of 13.3% 15.1% 7.6% N/A 20.0% gross consumption (2007) * Note: Figures represent annual renewable energy produced. Source: DBCCA Analysis, 2009; EWEA, Wind Energy: The Facts, March 2009; BMU, Renewable Energy Sources in Figures: National and International Development, June 2009, p 52; Ontario s Independent Electricity System Operator (IESO), Supply Overview, 2009; IESO, IESO 2008 Electricity Figures Show Record Levels of Hydroelectric, January 12, Paying for Renewable Energy: TLC at the Right Price

9 I. Paying for Renewable Energy: Costs, Benefits And Jobs 1.0 A more detailed cost-benefit analysis of the German FiT regime The German government has done several in-depth studies to find a more comprehensive evaluation of costs and benefits of a feed-in tariff regime. The strategic objective of the German government is to be a world environmental leader, to establish Germany as the global environmental service provider of the 21 st Century, and to accelerate new growth and job creation. The Ecological Industrial Policy seeks to bring about revolutionary technology advances across the entire energy value chain. 3 The three broad goals of the integrated policy are: 1. Improving energy security 2. Providing cost effective energy 3. Lowering the environmental impact of energy use The success of German FiT policy in meeting its long term strategic objectives can be illustrated by analysis carried out primarily by the German Federal Environment Ministry (BMU). Boxes 1.1 and 1.2 present an evaluation of the costs and benefits of Germany s FiT as well as a detailed view of the benefits. As already mentioned, the complex relationships between the figures below mean that they cannot be easily compared to derive a single, net result. However, in our view, the boxes below show substantial benefits in relation to the costs. Box 1.1: Evaluating costs and benefits of the German feed-in tariff : Electricity Sector Costs Incurred: Differential cost 1 (Premium above calculation cost): 8.6 billion 2 Balancing cost 3 (2006 estimate of billion 2 x 3 years): billion 4 Expansion of grid: 1 billion (estimate) 5 Effect on Energy Security*: Electricity import savings: 2.2 billion 6 Merit Order Effect: Avoided electricity generation of the most expensive fossil fuel plants: 9.4 billion 7 * Note: Energy security is not specified as a cost or benefit because the import savings affect several parties differently (i.e. it causes distributional effects). 1 The differentiated cost is the difference between fees paid by the grid operators to the renewable energy generators and the average electricity wholesale purchase costs. It includes costs borne by the ratepayer. The Renewable Energy Sources Act (EEG), which is the cornerstone FiT law, distributes the costs across the country and splits them among ratepayers. The average addition to the electricity bill has been 2-3 per month from The EEG surcharge grew from 0.2 cents/kwh in 2000 to 1.1 cents in Source: BMU, Renewable Energy Sources in Figures: National and International Development, June 2009, p BMU, Renewable Energy Sources in Figures: National and International Development, June 2008, p Represents the additional costs borne by grid operators balance the electricity supply, additional transaction costs. 4 Calculations built off of 2006 estimate from footnote #2. 5 Barbara Breitschopf, Fraunhofer, December 12, (Provisional figure) 6 BMU, Renewable Energy Sources in Figures: National and International Development, June 2008, p BMU, Renewable Energy Sources in Figures: National and International Development, June 2008, p EEG Progress Report, Paying for Renewable Energy: TLC at the Right Price

10 I. Paying for Renewable Energy: Costs, Benefits And Jobs Additional Benefits Box 1.2: A closer examination of the benefits from the German FiT Jobs: Jobs Created: According to the calculations of the German government, by June 2009 over 280,000 jobs in the renewable energy industry were created, of which the German government attributes about 66% occurring directly from the EEG. 8 The estimated net employment effect in 2006 was 67,000 to 78,000 new jobs created. 9 Economy: Net Impact on the Economy: Annual renewable energy turnover (investment and operation) has increased from 10 billion in 2003 to 28.8 billion in Technology Sales: As of 2008 Germany's renewable technology market share of global sales was 8%. 11 The national goal is to increase these global sales to 20-30% of market share by Domestic Electricity Share: Renewable energy generation as a share of gross electricity consumption increased from 4.3% in 1997 to 15.1% in Germany has met its 2010 target to obtain 12.5% of electricity from renewable energy and is on track to meet its 2020 goal of 30%. 13 Investment Growth: The annual investment Compounded Annual Growth Rate (CAGR) average is 55% and the cumulative investment CAGR is 93% for the years Investment into Germany's clean energy sector as a percent of its GDP is approximately 2-3 times greater than that of the US. 15 Growth in Exports: From 2004 to 2007, manufactured PV exports rose from 14% to 43% of total solar industry sales ( 7 billion in 2007). 16 In 2007 German wind power companies had revenues of 11.7 billion, of which 70% of sales were exports. 17 Patents Held & Innovation: Germany currently ranks third (behind the US and Japan) in the number of solar patents held. 18 The high level of firm clustering creates research hubs for collaboration, learning and further innovations. 19 Environmental Protection: Avoided CO 2 Emissions: The EEG has avoided 53 million tons of CO 2 in 2008 through the electricity sector. 20 Avoided External Costs: Expenditures of 2.9 billion in macroeconomic externalities, such as health and material damages and agricultural revenue losses, were avoided in BMU, Renewable Energy Sources in Figures: National and International Development, June 2009, p BMU, "Background Report on the EEG Progress Report 2007", December 2007, p BMU, Renewable Energy Sources in Figures: National and International Development, June 2009, p Germany Trade & Invest, Powerhouse Eastern Germany: The Prime Location for Cleantech Leaders, 2008, p BMU, Renewable Energy Sources in Figures: National and International Development, June 2009, p Economist, German lessons: An Ambitious Cross-subsidy Scheme Has Given Rise to a New Industry. April 3, New Energy Finance, includes PE/VC, AF, Public Markets. Note: Investment figures are based on New Energy Finance s PE/VC, Asset Financing and Public Markets database, which comprises of disclosed investment amounts. This may not accurately represent all investments made in the renewable energy sector during this time period. Market cap data is sourced from Bloomberg, Investment data from New Energy Finance; GDP data from OECD Statistics; DBCCA analysis, BSW. Statistische Zahlen der deutschen Solarstrombranche (Photovoltaik), März Germany Trade & Invest, Powerhouse Eastern Germany: The Prime Location for Cleantech Leaders, 2008, p Cleantech Group. Clean Energy Patent Growth Index, 3rd Quarter Michael Storper, Lecture in GY 407: Globalization: Theory, Evidence and Policy, Lecture 3, London School of Economics, October 16, BMU, Renewable Energy Sources in Figures: National and International Development, June 2009, p BMU, Renewable Energy Sources in Figures: National and International Development, June 2009, p Paying for Renewable Energy: TLC at the Right Price

11 I. Paying for Renewable Energy: Costs, Benefits And Jobs 2.0 Ontario looking to create a competitive low-carbon growth economy As another example from a robust tariff regime, the government of Ontario sees many opportunities and benefits stemming from their green energy policies, in particular the feed-in tariff law. In many senses, the Ontario government sees this as their entry into the new competitive low-carbon economy. Ontario, like some other FiT regimes, does have a local content requirement. As economists, we note that these sorts of policies can lead to distortions in trade. Box 2: Ontario Looking for significant economic benefits Ontario s Green Energy Act (GEA), and related amendments to other legislation, received Royal Assent on May 14, The landmark Green Energy Act will boost investment in renewable energy projects and increase conservation, creating green jobs and economic growth to Ontario. This legislation is part of Ontario s plan to become a leading green economy in North America. The GEA will: Spark growth in clean and renewable sources of energy such as wind, solar, hydro, biomass and biogas in Ontario attracting foreign direct investment; Create the potential for savings and better managed household energy expenditures through a series of conservation measures; Create 50,000 jobs for Ontarians in its first three years, particularly longer term manufacturing ones; Achieve the goal of phasing out coal-fired electricity generation by Our ambition is to increase the standard of living and quality of life for all Ontario s families. That is best achieved by creating the conditions for green economic growth. -George Smitherman, Deputy Premier and Minister of Energy and Infrastructure. Source: Ontario Ministry of Energy and Infrastructure website: Green Energy Act. 11 Paying for Renewable Energy: TLC at the Right Price

12 I. Paying for Renewable Energy: Costs, Benefits And Jobs 3.0 Fossil fuel subsidy costs Also a factor to consider There are many historic reasons that countries have subsidized fossil fuels; however, we believe that in evaluating costs and benefits, an area that requires further research and inclusion is the role of fossil fuel subsidies. Below, we cite some work that has been done in this area. Box 3: The role of subsidies: Fossil fuels much more heavily subsidized than renewable energy On a global scale, energy is subsidized heavily to the tune of about $300 billion annually, according to the International Energy Administration (IEA). While this is a large number in the aggregate, on a ton of oil (TOE) or British Thermal Unit (Btu) equivalent basis fossil fuel subsidies are much lower than renewable energy, which reflects their dominance in the global energy mix. Approximately 75% of the subsidies are for fossil fuels and the balance is directed toward electricity, much of which is generated from them. The gross amount of energy subsidies varies substantially by country and industry. Energy subsidies can be direct or indirect and can be levied on either production or consumption. There are many historic reasons why countries have subsidies for fossil fuels, however when doing a cost/benefit analysis at a macro economic level, it is important to account for the impact of energy subsidies across all sectors of the economy. The net effect is a distortion in the energy price to a below market reference level, which affects behaviour and impacts wealth transfers between producer, consumer and governments. On the production side, subsidies are generally bucked into tax breaks, cash grants or enshrined in regulation protecting producers. On the consumption side, which is more common in developing countries such as India and China, the government regulates fuel prices and sells them below market to consumers at a fixed price. It has been argued that a more direct approach to dealing with the carbon externality in lieu of a tax or cap-and-trade in the short run is eliminating fuel subsidies. This appears to be the direction governments are going. At the G-20 meeting in September 2009, leaders of the world s largest economies agreed to end fossil-fuel subsidies, and committed to phasing out the subsidies over the medium-term, blaming them for encouraging wasteful consumption and undermining efforts to combat climate change. Citing studies by the Organization for Economic Cooperation and Development (OECD) and the IEA, the G-20 said that eliminating fossil fuel subsidies by 2020 would reduce greenhouse gas emissions in 2050 by ten percent. In the US, most of the largest subsidies to fossil fuels were written into the US Tax Code as permanent provisions. By comparison, many subsidies for renewable energy are time-limited initiatives implemented through energy bills, with expiration dates that limit TLC. The vast majority of subsidy dollars to fossil fuels can be attributed to just a handful of tax breaks, such as the Foreign Tax Credit ($15.3 billion) and the Credit for Production of Non-conventional Fuels ($14.1 billion). The largest of these, the Foreign Tax Credit, applies to the overseas production of oil through an obscure provision of the US Tax Code, which allows energy companies to claim a tax credit for payments that would normally receive less-beneficial tax treatment. Fossil Fuels $72.5bn - Traditional Fossil Fuels $70.2bn - Tax Breaks $53.9bn - Direct Spending $16.3bn - Carbon Capture & Storage* $2.3bn Renewable Energy $ Traditional Renewables $ Corn Ethanol** $16.8 Sources: Internal Revenue Service, US Department of Energy (EIA), Congressional Joint Committee on Taxation, Office of Management and Budget, & US Department of Agriculture, via Environmental Law Institute. *CCS is a developing technology that would allow coal-burning utilities to capture and store their carbon dioxide emissions. Although this technology does not make coal a renewable fuel, if successful it would reduce GHG emissions compared to coal plants that do not use this technology. **Recognizing that the production and use of corn-based ethanol may generate significant GHG emissions, the data depict renewable subsidies both with and without ethanol subsidies. 12 Paying for Renewable Energy: TLC at the Right Price

13 II. Renewable Energy Policies: Key Design Features Summary: In this chapter, we look at the key policy design elements used for renewable energy incentives, drawing on elements from the detailed sections that follow. Renewable energy policy sits within the framework of overall climate policy and energy security concerns. In order to achieve an adequate response, policy makers have to satisfy investor needs for Transparency, Certainty and Longevity (TLC) while seeking to minimize costs. Feed-in tariff regimes offer TLC and advanced features for price discovery and cost minimization. The US relies on RPS systems and supporting policies which are highly complex and lack elements of TLC. The best attributes of advanced FiTs can be adapted to the US renewable energy policy mix. As the world grapples with the aftermath of the economic recession, a continued build up of carbon in the atmosphere and long term questions about how to source secure, diverse and clean energy, government policy remains central to solutions to these issues. Encouraging the scale-up of renewable energy projects can address these issues. From the perspective of DB Climate Change Advisors (DBCCA), addressing the climate issue is crucial and the key driver for how we see renewable energy policy. 1.0 The climate policy framework for renewable energy Climate Change Policy still remains a work in progress as the world gathers in Copenhagen (December 2009). Since we published Investing in Climate Change 2009 (October 2008), we have argued that there are three main ways that policy makers are engaged in pricing the carbon externality, which is an economic and market failure issue: 1. Carbon Markets directly establishing a carbon price either through a tax or cap-and-trade programs; 2. Mandates and Standards requiring a combination of renewables, energy efficiency, transport, and industrial sector targets and; 3. Innovation Policy incentives designed to get specific technologies to deliver volume response if they are not already commercially viable and reduce their costs. For economists and policy makers, the question is how can climate mitigation targets be met in the most time sensitive and cost efficient way, and in the current economic context, can they help create jobs? Many economists suggest a carbon price, most likely a straightforward tax, is the best way, leaving the market to select technologies. However, the political and market reality, particularly in an international context, means that an unconstrained approach to carbon pricing is not possible, particularly at an international level. A more likely approach is a slow buildup of cap-and-trade regimes to establish carbon prices that can lead to international linkages. However, it is hard to see a carbon price of sufficient magnitude in the next few years to cause major changes to the energy mix of the OECD. Hence the need for complementary policies, often referred to as mandates, standards and incentives. Here policy makers need to make more proactive decisions about which technologies to encourage and importantly how to incentivize them. These complementary policies can further be designed to integrate with emerging carbon markets (for instance, by being incorporated into emission baselines) as they produce volume response and lower the cost of technologies as they scaleup. By incentivizing all available post demonstration proven renewable technologies at the appropriate cost level, policy makers can address criticisms of picking winners. Mandates and standards can be considered as a demand pull, whereas incentives can create supply push; these are complimentary with each other. Additionally, these policies can be designed to integrate into a carbon market. Furthermore, as with carbon markets, international cooperation to harmonize complementary policies to ensure level-playing fields, is considered highly beneficial. 13 Paying for Renewable Energy: TLC at the Right Price

14 II. Renewable Energy Policies: Key Design Features The optimal approach would seem to be that complementary policies encourage technology cost reductions (i.e. which during the learning process are like a R&D subsidy) and fill the gap before a robust carbon market emerges and then fades, so long as persistent behavioral barriers are not found to be present, such as in areas like energy efficiency. That leaves a carbon price for any long-run incorporation of pricing the carbon externality into proven technologies. This is illustrated in Exhibit 2 below in terms of Levelized Cost of Energy (LCOE). EX 2: Timeline and incentive structure to achieve commercial break-even (grid parity) for a technology Source: DBCCA analysis, Looking at the key areas that are expected to deliver a substantive amount of mitigation potential, we find that in Exhibit 3: 1. Energy efficiency technologies are the cheapest option and have the most mitigation potential however they are affected by behavioral barriers that require mandates and standards; 2. Forestry and Agriculture also have significant potential but behavioral issues are also evident in these sectors; 3. Renewable energy technologies might be able to reduce their costs to commercial break-even given historic learning rates, but most currently need mandates and incentives and; 4. The more expensive solutions, particularly Carbon Capture and Storage (CCS), will require a carbon price to equalize their cost against fossil fuels for the long run. 14 Paying for Renewable Energy: TLC at the Right Price

15 II. Renewable Energy Policies: Key Design Features EX 3: 2030 Global GHG incremental abatement cost and technical potential vs. current technical maturity CCS = Abatement Potential (Gt) Abatement Cost (EUR/tCO2e) Renewable Energy Nuclear Agriculture Forestry (10) (20) Energy Efficiency (30) Low Maturity Source: DBCCA analysis; McKinsey Climate Desk, High Maturity 2.0 Investor response Investors need to respond to renewable energy policy frameworks and they are looking for TLC: Transparency How easy is it to navigate through the policy structure and understand and execute? Longevity Does the policy match the investment horizon and create a stable environment for public policy support? Certainty Does the policy deliver measurable revenues to support a reasonable rate of return? Failure to stimulate investor interest will lead to failure to achieve any target. Much of our recent work examines how investors respond to policy regimes. We have placed particular emphasis on the quality of incentives. Increased transparency and certainty can clearly reduce risk and allow developers to obtain a lower cost of capital. However, if achieved through overly generous fixed incentives, the cost could prove higher than a policy maker would want to pay, potentially leading to a withdrawal of the policy as public support wanes. 15 Paying for Renewable Energy: TLC at the Right Price

16 II. Renewable Energy Policies: Key Design Features 3.0 Optimizing policy: TLC at the right price Bringing together policy goals and investor needs, we examine what might be considered a best practice proposition for the scale-up of renewable energy. We see the goals of policy makers in renewables in the next decade as carbon markets take time to mature, as follows: 1. Encourage early stage research, but concentrate on all available post demonstration and proven technologies that can grow to significant scale. This addresses criticisms about picking winners. 2. Establish renewable energy targets consistent with climate change and energy security goals. 3. Use a mix of on the ground mandates, standards and incentives that will establish TLC for markets, and achieve a meaningful volume response. 4. Encourage cost reduction and a fair return in technologies to sustain public support for policy. Public support is important to ensure longevity of the policy for investors. There is tension is between certainty to an investor and a pathway to commercial break-even that includes price discovery, i.e., getting up-to-date input on actual market costs and investor returns. It is optimizing this that will produce the best set of policies. Renewable energy policy should seek to achieve: Volume response in support of an emissions target that creates investor TLC, and establishes a pathway (subject to transparent price discovery) to achieve commercial break-even (grid parity) for proven and demonstrated technologies. 3.1 Policy Levers What s Available When looking around the world at renewable energy policy, as set out in Climate Tracker, we can see a number of key policy levers that are being used to mandate and incentivize renewable energies: Mandates: Set volume targets (renewable portfolio standards (RPS) or renewable electricity standards) which can generate compliance certificates (RECs/ROCs) Direct Incentives: Such as production-based feed in tariffs (FiTs), and capacity-based grants and rebates Tax Incentives: Tax credits (PTC/ITC which can be converted into cash grants), tax exemptions Financial programs: Loan guarantee programs, low-interest loans, government guaranteed bonds In this paper, we analyze FiT systems in Europe and Ontario, state RPS markets and federal tax incentives in the US. We also briefly look at the Loan Guarantees and Green Banks. In doing this, we take into account: The extent to which these policies satisfy the criteria for TLC Best practices in FiTs we term these Advanced FiTs How costs/returns can be optimized for investors and policy makers The question naturally arises as to how complementary these incentive policies are. How can a RPS market interact with FiT, tax credit, and Loan Guarantee programs? We set out how we believe these levers do and can interact. 16 Paying for Renewable Energy: TLC at the Right Price

17 II. Renewable Energy Policies: Key Design Features 4.0 Looking at feed-in tariffs Standard offer renewable payments As set out in our recent paper looking at the scale-up of renewable energy in Germany there is strong evidence that renewable energy targets can be met through a strong volume response incentivized by Feed in Tariffs (FiTs). We further expanded upon the effectiveness of the volume response in our Climate Tracker 4 and contrasted some of the key elements of a FiT with a more market based Renewable Energy Certificate (REC) approach. In this paper we take the analysis further, especially in respect to the economics, pricing, and cost impact of deploying FiTs. In doing so we are looking for what could be termed Advanced features, particularly in relation to price discovery. We examine FiTs in France, Germany, Netherlands, Ontario, and Spain. While not the focus of this paper, we are also interested in studying at the latest thinking in FiTs that are either in discussion or being proposed. As of publication, the UK, US, India and China all have proposals on the table, although we do not address these here. The core elements of any FiT are: 1. Defined eligible technologies; 2. Tariff pricing differentiated by technology; 3. A standard offer (frequently expressed through a contract), for a guaranteed payment for renewable electricity generation; 4. A guaranteed interconnection for all renewable generators and; 5. Payments over a long timeframe. A FiT can be designed to cover a wide range of project sizes, ownership, structures and technologies. In most markets, with the exception of Spain 5, independent power producers (IPPs) have tended to be the predominant owners and it is often the case that both large-scale and small-scale distributed technologies have benefited from FiTs. The two main tariff pricing structures, a fixed long term purchase price and a variable premiums added to the market price, can include a number of other more advanced design elements. In general, fixed pricing fosters a higher degree of revenue certainty, which is an important element for an investor. In terms of volume targets, FiTs usually sit within a renewable energy goal or portfolio standard, but volume response is not necessarily limited to the target amount, as in the US REC approach (see below). Chapter III shows the major features of FiTs as illustrated by five key regimes that we believe are useful to analyze their effectiveness in terms of TLC and how much price discovery they contain. 4.1 Looking for TLC with price discovery Drawing on the existing FiT policy regimes as set out in 3.0 above and the optimal policy goals described above, we believe that a definition of an Advanced FiT building on the core features might include the following features. Supporting a mandated renewable energy target by creating investor TLC with a pathway subject to transparent price discovery to grid parity. Below, we highlight what we consider to be the key features that deliver TLC at the right price in a FiT tracked against the key regimes we have examined. 4 DBCCA, Global Climate Change Policy Tracker: An Investor s Assessment, October Stenzel and Frenzel, Regulating technological change The strategic reaction of utility companies towards subsidy policies in the German, Spanish and UK electricity markets, Energy Policy, Paying for Renewable Energy: TLC at the Right Price

18 II. Renewable Energy Policies: Key Design Features EX 4: Key features for TLC at the right price FIT Design TLC at the Key Factors Features Right Price Policy & "Linkage" to Economic Yes 23% by % by % by 2020 mandates & targets Framework Core Elements Supply & Demand How to set price How to adjust price Caps Eligible technologies Specified tariff by technology Standard offer/ guaranteed payment All renewables eligible France Germany Netherlands Ontario Spain Wind, Solar, Geothermal, Small hydro, Biomass, Biogas Wind, Solar, Geothermal, Small hydro, Biomass, Biogas Wind, Solar, Biomass, Biogas, CHP Halt coal use by 2014 Wind, Solar, Hydro, Biomass, Biogas 20% by 2020 Wind, Solar (PV & CSP), Geo, Small hydro, Biomass, Biogas Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Interconnection Yes Yes Yes Yes Yes Yes Payment term 15-25yrs 15-20yrs 20yrs 15yrs 20yrs 15-25yrs Must take Yes No Yes No Yes Yes Who operates (most common) Open to all IPPs; communities; utilities IPPs; communities; utilities IPPs; communities IPPs; communities IPPs, communities; utilities Fixed Structure & Adjustment Fixed vs. variable price Fixed Fixed Fixed Hybrid Fixed Both Generation cost vs. avoided cost Generation Generation Generation Generation Generation Generation IRR target Yes 8% 5-7% No 11% 7-10% Degression Yes Wind only Yes No No No Periodic review Yes No Yes Yes Yes Yes Grid parity target Yes No Yes No No No Project size cap Policy Eligible for other interactions incentives Transaction costs Streamlining minimized Source: DBCCA analysis, Depends on context Yes - eligible to take choice Varies No Yes PV only Yes Yes Yes Yes Yes Yes Yes Yes Yes No Yes No 1. A direct connection to RES/RPS policies could be made by integrating FiTs into existing frameworks. 2. Allowing all proven renewable technologies that are appropriate for a given context to be eligible prevents picking winners particularly when the tariff is differentiated by technology cost. 3. A standard offer / guaranteed payment over a long time horizon is a key core element of any FiT and are essential for complementing advanced features of FiTs. 4. Mandatory interconnection to the grid. 5. Must take provisions will allow for a broad range of generators to come online, including distributed and small scale projects. There may be limitations to must take requirements, depending on the policy objectives and infrastructure constraints (e.g. transmission) of a given country or state. 6. Any entity - utilities, communities and IPPs should be eligible to participate in a FiT scheme. This creates a resilient investment environment. 7. Fixed pricing structures provide greater TLC than variable pricing. 8. Determining the tariff rate on a generation cost basis (which includes a reasonable return) rather than through avoided costs (the value of new generation to the utility) provides greater certainty for receiving a return on investment and is also more transparent. 9. An initial tariff or payment that reflects the IRR required to develop renewable energy projects. 18 Paying for Renewable Energy: TLC at the Right Price

19 II. Renewable Energy Policies: Key Design Features 10. A tariff degression schedule which steps down to a grid parity (i.e. commercial or LCOE break-even) target. The degression would not alter the payment terms of existing renewable installations but would decrease the tariff for facilities that come online in future years. These schedules could include: a) Straight line reduction from the starting tariff to grid parity, and b) DBCCA recommends adjustments to meet changing market developments and reflect technology learning curves. 11. The grid parity target projected for the particular electricity market that the advanced FiT is operating in. This could be adjusted for long term price trend estimates, and adjusted to meet changing electricity market environment. 12. The starting tariff, degression and grid parity points could all achieve price discovery by being based on: a) Surveys accompanied by market research, based on latest costs and IRR expectations of generators in particular technologies (not avoided costs). DBCCA recommends this approach (see below). b) Competitive benchmarking process, setting a price based on the outcomes of i. A competitive bidding (RFP), or ii. An auction process 13. Project size caps should depend on the policy objectives and contextual electricity infrastructure. Some policy makers, for example, argue that feed-in tariffs should be used to support smaller scale generators, whereas alternative mechanisms (e.g. competitive bidding) should be used to target larger scale projects. Feed-in tariff policy makers have taken different approaches to the issue of project caps. Spain, for example, has a project cap of 50 MW. In the US, several states (such as California, Hawaii, Illinois, Indiana, Michigan, Minnesota, New York, and Rhode Island) have introduced legislation adopting feed-in tariffs with a 20 MW cap for certain resources, and this same cap has been suggested as part of the proposed federal FiT. 14. Renewable energy producers should be eligible to choose if they want to take advantage of other incentives and in doing so, the FiT payment should be adjusted accordingly. The FiT tariff should not build in the assumption that all producers will qualify for and use every possible incentive. 15. Transaction costs should be minimized in order to set TLC and quicken the deployment rate of renewable technologies. EX 5: Efficient tariff pathway to grid parity (1) Tariff payment established via survey of cost + profit = IRR Payment term of years $/MWh (3) Tariff degression adjusted by survey review based on IRR AND / OR review triggered by volume response (2) Grid parity target Source: DBCCA analysis, Time 19 Paying for Renewable Energy: TLC at the Right Price

20 II. Renewable Energy Policies: Key Design Features Many of the design features listed above try to bring in price discovery in some way. The issue here is how it affects TLC. There needs to be transparent rules as to when and how a tariff review might happen, and the review cannot substantially reduce certainty over cash flow streams. Ideal rules would include: 1. Existing tariffs cannot be changed this is essential. Price adjustments would only affect the tariffs paid to facilities that have yet to come online. Reviews would not alter the payments of installations already in existence. 2. There would not be less than two years between reviews. Reviews should occur on a transparent and predictable schedule, and be administered according to grid parity objectives. An alternate approach is to trigger a review when a certain volume level has been reached. Germany has an element of this for solar PV. 6 A cap goes further and sets the limit specifically. Caps have the advantage of controlling overall costs but need to be designed carefully to prevent speculative queuing and gaming Survey vs. RFP / Auction for Price Discovery 1. A survey by a regulator would need to be wide and deep around the technologies. It would need to gauge the quality of respondent and ability to deliver volume. Track record would be important. Feedback loops whereby generators would be required to share actual cost and performance data would make the process more robust over time. 2. Competitive benchmarks, such as auctions, would be used to set the initial tariff price and adjust the payments for future facilities that become operational.. The issues here are gaming, the introduction of higher transaction costs and project development risks, and understanding if the bidders can really deliver the volume. 3. We favor a survey process Independent Power Producers (IPPs) and Utilities As already mentioned, current FiTs have driven significant growth in smaller scale, distributed technology solutions such as residential rooftop solar PV, frequently owned by IPPs. In these cases, utilities primary roles are to pass through the tariff and make the interconnection. A distributed IPP model is certainly a reasonable approach. However, in order to get to maximum impact it would be important to create incentives for a diverse range of renewable generation ownership structures. Both ownership cooperatives and utilities should have access to a FiT in the appropriate technologies wind, solar CSP and large scale solar PV, for instance. However, projects over 20MW are of such magnitude that many policy makers think that a more direct negotiation process would deliver a better outcome. 4.2 How Advanced Are Recent FiTs Germany and Ontario? As shown in Chapter IV Section 7.0, FiTs in leading markets have covered TLC they are generally transparent, last up to 25 years and give high levels of certainty over cash flow payments for IRR calculation. Price discovery features are more common now. They sometimes make an IRR target an explicit part of the policy. Two of the most advanced FiTs in our view at present are Germany and Ontario. Both systems initially set the tariffs through surveys in order to establish transparent, long term, fixed prices based upon different technologies generation costs, plus a small profit. Both Germany and Ontario then account for market changes and reductions in technology costs through systematic reviews based upon rigorous market research. These reviews do not change existing payments but change the payments for future facilities that come online. Germany has a responsive degression rate, which can change 6 German RES Act Paying for Renewable Energy: TLC at the Right Price